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Investment and the weighted average cost of capital

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  • Frank, Murray Z.
  • Shen, Tao

Abstract

In a standard q-theory model, corporate investment is negatively related to the cost of capital. Empirically, we find that the weighted average cost of capital matters for corporate investment. The form of the impact depends on how the cost of equity is measured. When the capital asset pricing model (CAPM) is used, firms with a high cost of equity invest more. When the implied cost of capital is used, firms with a high cost of equity invest less. The implied cost of capital can better reflect the time-varying required return on capital. The CAPM measure reflects forces that are outside the standard model.

Suggested Citation

  • Frank, Murray Z. & Shen, Tao, 2016. "Investment and the weighted average cost of capital," Journal of Financial Economics, Elsevier, vol. 119(2), pages 300-315.
    • Handle: RePEc:eee:jfinec:v:119:y:2016:i:2:p:300-315
    DOI: 10.1016/j.jfineco.2015.09.001
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    More about this item

    Keywords

    Weighted average cost of capital; Investment; CAPM; Implied cost of capital;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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